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Japan Is Gaining Momentum (NYSE:EWJ)

December 24th, 2012

Here’s some political trivia you can use at your next holiday cocktail party: Who’s the only U.S. president to lose re-election and then come back to win again?

Grover Cleveland.

In fact, while saying goodbye to the White House staff, the young and vivacious Mrs. Cleveland’s last words were, “We’ll be back.”

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In Japan, a comeback happened just last Sunday as Mr. Shinzo Abe, thrown out with the Liberal Democratic Party (LDP) in 2007, will return as prime minister after a smashing victory and supermajority in the Diet’s lower house.

But is this good news for Japan’s stock market, which is down 40% since Mr. Abe left in 2007? What about its economy?

While an exchange student in Japan in the 1980s, I learned that most Japanese don’t expect much from politics – viewing it as part Kabuki play and part inside baseball. But while prime ministers came and went, the LDP was one constant since WWII.

Then came the bursting of the Japanese bubble in 1989 to 1990 that put Japan in a funk for more than two decades. During this time there were 17 prime ministers and nine stimulus plans, and the Nikkei is down 75%.

Gaining Momentum

Since the election was called about a month ago, Japan’s market surged 14%. This momentum should continue near term for a number of reasons.

First, Mr. Abe is committed to getting the Bank of Japan to pump liquidity into its economy to try to get some mojo going.

Second, this will help push down the value of the Japanese yen. It’s risen about 25% since 2009, boosting exports and the top-heavy, export-oriented stock market.

But don’t get carried away. The Japanese economy faces staggering demographic and debt headwinds. The proportion of Japanese 65 and above has gone from 5% in 1950 to 25% in 2012.

By 2030, there will only be two workers for every one retiree.

One plank in the LDP’s campaign called for more stimulus and infrastructure spending. But how does this square with a national debt almost 2.5 times its GDP? Will the new government repeal the proposed increase in the consumption tax in April 2014?

And what about long-overdue, but tough, structural reforms in agriculture, banking and trade? It might surprise you to learn that Japan ranks twenty-fourth in the world in ease of doing business surveys –far below eighth-ranked rival South Korea.

In short, where’s the growth agenda?

Another Issue to Keep An Eye On

There’s another important issue that investors need to keep an eye on. Mr. Abe definitely played the nationalist card in calling for Japan to be more assertive in foreign affairs. The ongoing dispute with China over islets in the East China Sea recently led to protests and 10 billion yen of damages to Japanese businesses in China. Chinese visitors to Japan dropped 33% in October. And Japan remains the biggest direct investor in China – twice that of America.

It’s worth noting that Japan’s new “Restoration” party, which takes an even harder nationalist line than the LDP, surged in the election to become a very credible third force in Japanese politics.

This is interesting stuff, but back to the practical matter of how to invest in Japan.

Near term, banking on a weaker yen should point you to large-cap multinationals or a basket of these companies through the

iShares MSCI Japan Index (NYSE: EWJ).

But you can do a lot better picking stocks that are overall trading around breakup value.

One reason many Japanese stocks are performing poorly is because management doesn’t put a high priority on share price. Management is paid in cash – not stock options – so goals like market share and top-line growth are a higher priority than stock price. This also leads to Japanese companies constantly raising new capital by issuing new shares, thereby diluting existing shareholders.

If you can identify smaller, high-growth Japanese companies with a significant equity stake held by management, you could really knock the cover off the ball.

Good Investing,

by Carl Delfeld, Investment U Senior Analyst


NYSE:EWJ


 

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